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After three years of handsome returns for U.S. stocks, the optimism of our Big Money pros is waning as the list of things to worry about grows longer. Just under half of the money managers who responded to our fall survey describe themselves as bullish or very bullish about the market's potential through June 2013.

While still outnumbering the bears, the bulls have shrunk to 46% of respondents, down from 55% in our spring poll and 52% a year ago. Those who have pulled in their horns certainly have good reason for doing so. Corporate earnings growth is slowing, there's the threat of war in the Middle East and defaults in Europe, and the fiscal cliff and a contentious election are approaching in the U.S. Yet the Big Money bulls expect the Dow Jones Industrial Average to rise to about 14,400 in the next year.

Scott Pollack for Barron's

To be optimistic about the future, a money manager must be a bit of a contrarian, as is David Daglio, a portfolio manager at Boston Co. Asset Management. "I don't think the economic climate is nearly as weak as the consensus believes," he says. He's particularly encouraged by the increase of consumer wealth to $63 trillion in the second quarter, up from $53 trillion in 2008. A wealthier consumer will foster the nascent rebound in housing, which, he estimates, could boost economic growth by 0.5 to one percentage point.

Recent economic data might support his case. Last week, unemployment claims fell by 23,000, to 369,000, and September housing starts surged 15%, to the highest level in four years, according to the Commerce Department. And the Conference Board's Consumer Confidence Index jumped to 70.3 in September, up from 61.3 the prior month.

"The U.S. problems are solvable. This is not Greece," says Joseph Parnes, president of Baltimore-based Technomart Investment Advisors. America has enormous wealth, lots of resources, and a tradition of entrepreneurship, notes Parnes, who came to the U.S. from Iran to attend college and never left. If the S&P can produce $103 of earnings this year and the market's multiple widens slightly to 15 after the election and the fiscal cliff are just memories, the S&P 500 could climb to 1545 -- 10% higher than it is now, he maintains.

HOWEVER, MANY PORTFOLIO MANAGERS who defected from the bull ranks seem to have become quite pessimistic; 27% of our respondents now say that they are bearish or very bearish. That's almost double the 14% who were in the bear camp in April and up sharply from the 17% who were there a year ago. Today's naysayers see pain, but not Armageddon, ahead. They're calling for the Dow Jones Industrial Average to end up somewhere around 12,000 in a year. That would be 8% below today's level. The bears also expect the S&P 500, now around 1405, to slip below 1300 and the Nasdaq Composite, currently at 2965, to slump to 2705.

So what has changed in the past six months? The price tag on the market is much higher today, given the sharp rise in stocks over the summer and early fall, plus a subdued profit outlook.

The S&P 500 bounced around 1370 in April before a strong rally took it to a high of 1466, hit on Sept. 14. Even after the market's recent selloff, the benchmark index is still up almost 12% this year. Meanwhile, expectations for earnings gradually have ratcheted lower. S&P 500 profits are expected to decline 1.9% in the third quarter, down from expectations for a 2.8% increase on July 2, according to Thomson Reuters. Fourth-quarter estimates still call for growth of 8.4%, but that number was 14% in July. And while analysts have grown more pessimistic about earnings prospects for the next six months, they continue to wear rose-colored glasses when gazing into 2013, when profits are projected to rise 11%.

"Companies are running out of ways to offset the deceleration of revenue growth," says Jon Fisher, a portfolio manager at Fifth Third Asset Management in Minneapolis, who's bearish on stocks. "Earnings growth is decelerating, and earnings estimates are too high for next year."

At the same time, consumers, banks, and the public are all continuing to deleverage. As a result, economic growth will remain sluggish, contends Jason Brady, a portfolio manager at Thornburg Investment Management in Santa Fe, N.M. Although the Federal Reserve's low-interest-rate policy has pumped up equity and bond prices, he argues that "the margin of safety in stocks is not high." Brady has 10% of his portfolio invested in cash and short-term bonds, versus a typical 2% to 4%.

Higher stock prices and lowered earnings expectations go far to explain why the number of folks in our survey who believe that the market is overvalued has steadily climbed to 21%, up from 13% a year ago, while the percentage of those who consider stocks undervalued has shrunk to 25% from 61%.

Another sign of growing pessimism: Only 41% of respondents believe that equities will be the asset class that posts the best performance over the next six to 12 months. That's down from 73% in April and 63% a year ago.

Normally if investors don't like stocks, you'd expect them to be fans of bonds, but that's not the case right now.

Bonds certainly don't lack for positive news. On average, the pros who responded to our poll see the economy growing by 1% to 2.5% in 2012. And the Federal Reserve has broadcast that it will provide easy money indefinitely, a policy reinforced at last week's Fed meeting and one that supports bond prices. While about 70% of our respondents believe that the central bank will have to take further steps in the next year to keep rates at their current near-zero levels, 70% don't see inflation as a major threat during that period.

DESPITE THIS POSITIVE BACKDROP, money managers are shunning Treasuries, in large part because so much positive news already is priced into these key fixed-income securities. The 10-year T-bond yields a piddling 1.8%. Managers don't see rates moving meaningfully higher in the next six months. But even slight increases would result in losses to bondholders. Just over a quarter of Big Money participants expect the interest rate on the 10-year Treasury to be 1.5% in six months, 44% are looking for 2%, and 16% see 2.5%.

"I don't see any value in Treasuries," says Byron Snider, president of West Oak Capital, in Westlake Village, Calif. Instead, he owns tradable certificates of deposit, corporate bonds, agency paper, and some municipal bonds. Without the Fed's intervention, the 10-year T-bond would yield 5% -- roughly two percentage points, plus the inflation rate. If the Fed stopped buying Treasuries and yields moved up, investors in these securities would be clobbered, Snider warns.

He isn't alone. An overwhelming majority -- 89% -- of the managers responding to our survey consider Treasuries overvalued. Less than 2% expect fixed income to be the top- performing asset class in the next six to twelve months, and less than 5% see cash as the best bet.

BERNANKE AND FRIENDS don't have a large fan base among the Big Money managers. Just over 60% of them disapprove of the Fed's current interest-rate policy. And, of those who think the central bank will have to act again, 78% don't believe that further action will be fruitful.

The Fed's efforts elicited strong, detailed written comments from our respondents. "The Fed is well past the point of interest-rate policy having any meaningful impact on the economy," wrote one critic. "Bernanke & Co. now risk damage to both the [dollar] and the Fed's own balance sheet. This is the biggest misallocation of capital in the history of mankind."

Other critics raised concern that low rates are hurting savers and allowing government officials to delay the inevitable need to fix fiscal policy. Low interest rates "have just killed" retirees, who are buying dividend stocks and high-yield bonds to generate more income, says Marc Dion, principal at Morgan Dempsey Capital Management in Milwaukee. "People are incorporating more risk in their portfolios than they probably should" to get yield, he says. "I just think it's going to end badly."

Fed defenders were in the minority, but they do exist. "While very controversial, QE3 has a unique window to be implemented as worldwide growth is slow [and the low price of natural gas] is deflationary," says one Bernanke supporter. "While I don't think low rates are the key, I think low rates for a long time are. The government has little ability to turn things quickly. Only time can do that. Housing is key at this point and [so is] avoiding deflation."

James Vanasek, a principal at VN Capital Management in New York City, also defends the central bank: "Bernanke's actions since the 2008 financial crisis have staved off a major depression. He gets very little credit for doing an outstanding job." By steepening the yield curve, the Federal Reserve has improved the earnings at banks, thereby helping them to recover faster. The Fed's actions have also weakened the dollar, which has boosted exports.

Some of the central bank's critics worry that the easy-money policies will stay in place too long and result in inflation. So it makes sense that many of the money managers are bullish on hard assets. In fact, 80% are optimistic about the outlook for real estate, 69% are bulls on bullion, and 54% like commodities.

Asked to name the top-performing asset in the next year, 22% selected precious metals; 21% chose real estate, and 11% picked commodities.

GOLD HAS A SHINY FUTURE, according to the Big Money crew. They see it rising by roughly 9%, to $1,877 a troy ounce next year. But that average conceals a rather wide dispersion of estimates, with the lowest being $1,821 and the highest, $1,932. Oil looks range-bound to the money managers. On average, they see a barrel of crude priced in the mid-to-high-$90s in a year; petroleum is now in the high-$80s.

THE BIG MONEY POLL is published twice a year by Barron's, in the spring and fall. All data is compiled by Beta Research in Syosset, N.Y. The latest poll was e-mailed in late September, and drew responses from 131 institutional investors from across the country, representing both smaller firms and giant asset managers. Here is a more detailed look at some of the key issues addressed.

Despite the market rally of the past three years, investors are skeptical that the upswing will continue. Sixty percent of money managers responding to the Big Money poll say their clients are bearish.

"In general, [investors] are nervous. This market has done a lot of mental damage to people through the years," says Fisher. In fact, Daglio observes, investors are displaying some of the most pronounced bearishness ever seen in an up market.

Corporate chiefs aren't immune to the pessimistic environment, even as their companies sit on large piles of cash. The Conference Board's most recent reading of CEO confidence came in at 42 points in the third quarter, down from 47 in the second. A number below 50 indicates that most chief executives are negative about the economic outlook.

Just as worrisome, nearly one-third of the CEOs polled by the Conference Board reported scaling back their capital spending plans since January, while less than 10% reported increasing them. Daglio notes that capital spending, relative to depreciation, is at a 50-year low, which again is unusually depressed for a period in which the economy isn't in a recession.

Portfolio managers increasingly might be pessimistic about the market because their performance hasn't been so hot. Roughly half of the managers we surveyed said that they're not beating the S&P 500 this year in client accounts. Perhaps more tellingly, 43% acknowledged that their personal investments aren't outpacing the benchmark, either. According to Morningstar, 77% of all U.S. equity mutual funds are trailing the market.

The Fiscal Cliff

Investors' confidence would certainly get a boost if the White House and Congress would address the fiscal cliff before it becomes a cliff-hanger on Dec. 31.

If certain tax cuts aren't extended, they will expire at the end of this year, resulting in higher taxes for individuals and corporations and, probably, slower economic growth and a smaller federal budget deficit. If they are extended, economic and job gains probably will be stronger, but the deficit likely will rise more sharply.

The two major political parties strongly differ on how best to handle taxes. Forty-four percent of managers believe they'll reach a deal, but a larger 54% expect a decision to be postponed. Only 2% expect that a compromise of some sort won't be struck. "The two parties are going to have to cut a deal somewhere in the middle," says Vanasek.

It doesn't look like any compromise will be reached before the presidential election, as each party wants to wait to see if it will have an ally in the White House. But a deal would eliminate one of the major uncertainties overhanging the market. Some 22% of managers say a solution would be the main factor in sending U.S. stocks sharply higher.

The uncertainty about who will lead the country will be resolved on Nov. 6. Three- quarters of the money managers we surveyed think President Obama will be re-elected. But an overwhelming 79% believe that former Massachusetts Governor Mitt Romney would be better for the market and 83% think he would be better for the economy. Most of our respondents expect the balance of power in the Senate and the House to remain unchanged.

Once the electoral uncertainty fades, consumers might start to spend again, regardless of who's in the Oval Office, and that could help the market, says Parnes. Stocks might respond more favorably to an Obama re-election, Brady says, because President Obama is likely to keep Federal Reserve Chairman Ben Bernanke, whose policies have helped push up share prices. Romney has said he would replace Bernanke, creating uncertainty for the market on yet another front.

Regardless of who's elected, our Big Money managers have a long to-do list for the folks in Washington. Thirty-three percent want the president and Congress to focus first on reforming entitlement programs; 20% think job No. 1 should be boosting economic growth, while 18% give the nod to reducing government debt. Twelve percent think job creation should be the government's top priority, and another 12% say tax reform ought to top the to-do list.

"Until somebody steps up and restructures the promises of Social Security and Medicare that cannot be met, the fiscal situation in the U.S. will continue to deteriorate and drag the long-term health of the economy down with it," wrote one Gloomy Gus.

Market Attractiveness

If there is reason for optimism, it might be that the U.S. economy and stock market don't look so bad compared with other nations. Europe is bogged down by its debt-laden southern tier. China's economy appears to be slowing. And Japan can't figure out how to reignite growth.

More than 40% of money managers thought the U.S. would be the best-performing market in the world in the next six to 12 months. Only 16% thought emerging markets would do best, while 15% favored Europe, and 12%, China. "We're the nicest-looking ugly duckling on the block," quips Snider.

Indeed, for all of America's faults, including a yawning deficit, 68% of our respondents expected the dollar to strengthen against the euro, and 60% looked for the buck to strengthen against the yen.

Looking at Europe, the managers were optimistic that Spain, Italy, and Portugal would remain in the EU, although only 56% thought Greece would remain in the common currency.

Most of those surveyed expect the European Union's problems to linger. Almost 40% thought it would take five years for the EU to resolve its financial crisis and 23% thought it would take two years. And they weren't the pessimists; 19% thought a resolution would take a decade, and 15% said a lasting solution wouldn't be found.

"Europe becomes the Japan of the 1990s," says Vanasek. The Europeans, he added, will fail to solve their problems and economic growth will stagnate.

Favorite Stocks

In both bull and bear markets, some stocks outperform and others underwhelm. What do the managers think of some of the market's most hotly debated issues?

Snider disagrees with the fans of Apple. "I'll be surprised if Apple can stay on the robust growth path without Steve Jobs," says the manager, who doesn't own the stock.

Snider, who likes dividend-paying shares, is also avoiding Bank of America. "They're going to be mired in lawsuits for the rest of my life," he says.

IN GENERAL, OUR BIG MONEY PARTICIPANTS like the technology and financial sectors the most, with energy coming in third. The sectors they believe will do the worst in the next six to 12 months are utilities, consumer cyclicals, and financials.

At Thornburg Investment Management, Brady can buy anything, anywhere in the world, so long as it provides income. He's among the managers who like stocks in the energy sector, where valuations are modest. Specifically, he's a fan of
ENIe -0.9870340356564019%ENI S.p.A. ADSU.S.: NYSEUSD36.6546
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/Date(1425417621888-0600)/
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149987
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(E), which gets a valuation haircut because it's based in Rome. However, he views the Italian energy outfit as attractive because it is replacing its production with new oil and gas finds and boasts a 6% dividend yield.

Like many poll participants, Brady isn't thrilled with U.S. utilities. They're highly correlated to interest rates and they've had a nice run. "At these prices, I'm not sure it's a great risk-reward" proposition, he says.

Daglio is cautious on businesses selling into China and the emerging markets. That includes metals and mining companies and some industrial names. "The fundamentals are far stronger for domestically focused businesses."

Tech spending could be surprisingly strong, he contends, as could ad spending and commercial construction.